Vanguard Index Shift Could Mean Korean Buying Opportunity

By Brendan Conway

The $58 billion Vanguard Emerging Markets ETF (VWO), the third largest U.S. exchange-traded fund, may need to unload as much as $9 billion in exposure to South Korea’s stocks some time over the next several months. Here’s why.

This morning, as part of a big index reshuffling, Vanguard Group said it will switch its popular emerging-markets ETF to a FTSE Group benchmark in lieu of the current MSCI Inc. (MSCI) Emerging Markets Index. Read our full coverage here. Unlike MSCI, FTSE classifies South Korea as a “developed” market. That means the country’s stocks won’t be included in funds tied to FTSE’s emerging markets benchmark.

This, in turn, should result in Korean stocks’ deletion from the $58 million ETF as well as its mutual fund counterpart, the Vanguard Emerging Markets Stock Index Fund (VEIEX), some time over the next several months, which is the time frame Vanguard gave for its moves. MSCI said in a press release that it expects the moves — which affect 22 funds — to start in January, at which point they will be “staggered” over “a number of months.”

If we do the back-of-the-envelope math for just the Vanguard ETF, it works out to about $9 billion in Korean exposure that would need to be eliminated. That’s because the fund is about 16% invested in Korean stocks, according to XTF.com data.

Samsung Electronics (SMSN) is currently the most heavily weighted stock in the Vanguard ETF at 3.7%, according to XTF. The next Korean stock on the list doesn’t come until 20th place, with a 0.9% weighting for Hyundai Motors (HYMLY).

Stifel Nicolaus ETF trader Dave Lutz predicts that we may see some index-related selling pressure affecting the iShares MSCI Korea Index Fund (EWY). Actually, it may already be happening. The iShares Korea ETF is down 0.7% at this writing, whereas the Kospi closed flat. Other Korean indexes rose on the session.

In widely used ETFs, this leaves investors with the EWY or the iShares MSCI Emerging Markets Index Fund (EEM) for big bites of Korean exposure.

Put it all together and it could make a buying opportunity for investors who were already weighing a new Korea allocation, by taking advantage of rule-based selling that has nothing to do with company or country fundamentals.

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